Lesson from Savings and Loans Rescue
By Tim Ryan
Op-Ed Published September 24, 2008 by The Financial Times
The US Treasury and Congressional leadership continues to hammer out a proposal essential to restoring liquidity to the credit markets. As the debate rumbles forward, it is worth reflecting on a comparable series of events of roughly equal magnitude that found a similar solution – the savings and loan crisis.
Between 1986 and 1995, more than 1,000 insured, deposit-taking institutions with assets totalling more than $500bn were closed. Historically, S&Ls had operated under conservative financial models. But their expansion into new types of loans unfortunately coincided with newly lowered capital requirements and a period of volatile interest rates, forcing the closure of 30 per cent of these institutions.
The Resolution Trust Corporation was designed by Congress to liquidate the assets of insolvent S&Ls. By quickly and decisively bringing assets to auction, the RTC created a price discovery mechanism for frozen assets. Like forcing an intervention on someone who will not admit they have a problem, the RTC used auctions to force the market to hit bottom so it could eventually return to normal.
The agency took heat in the early days. The RTC was accused of driving down asset values across categories, including property. But buyers quickly returned and soon brought ever-higher bids to what had been an inoperable situation. By finding the market’s floor, stability and certainty replaced wild price swings which soon led to a healthy, recovering market. The RTC worked.
Until recently, Hank Paulson, Treasury secretary, and Ben Bernanke, Federal Reserve chairman, examined failures in the financial market on a case-by-case basis, building tailor-made solutions over the weekends, working more Sundays than a small-town preacher. But it is now widely recognised that neither the industry nor the global economy can continue to spend weekends holding its collective breath, waiting for the next announcement.
Instead, Mr Paulson and Mr Bernanke have launched a strategic, systemic effort to bring certainty and stability to our markets called the troubled asset relief programme (Tarp). In the debate that has ensued, Congress has offered additional provisions. Whichever are ultimately included, they should not reduce the likelihood of the programme’s use.
Further, given the uncertain state of the markets, the Treasury should be given near-maximum flexibility in terms of assets it may buy and how it will finance and sell them. We cannot create a programme this week only to find out down the road, while Congress is out of session, that the Tarp does not have the authority it needs.
The new programme must focus on three areas. First, it should bring liquidity to a broad range of financial products whose markets are frozen, including, at the secretary’s discretion, products not directly related to mortgage finance. The first successful auction will begin to restore price transparency, which is the second critical component.
Determining what these products are worth will not be easy. It will require care and professionalism to find a fair balance between today’s “fire sale price” and the “hold to maturity price”. But that balance is critical, both in the short term and long term. In the short term, finding the right price will minimise disruption to skittish markets already susceptible to wild price swings, and in the long term the effective pricing provides an opportunity for American taxpayers to make a profit. The expertise to price, buy, restructure and re-sell these assets does not currently exist within government. Therefore, and finally, the Tarp must also be a ruthless outsourcer, as the original RTC was in its day. Of course, any outside contractors must ultimately be accountable to the government, which must have final decision-making authority.
The primary difference between the RTC and today’s Tarp proposal is one of pricing. The RTC assumed assets through S&L government takeovers and only priced them on the way out through auction. But Tarp will provide price discovery to the market twice, both when it buys assets and again when it sells them through auction or securitised sale.
Even though the S&L crisis directly affected the deposits of millions of Americans, Congress did not act until August 1989 – years after the first S&L failure and safely after an election. Today’s high cost or non-existence of credit, rapidly shrinking liquidity and general crisis in confidence in global capital markets directly or indirectly affects everyone linked to the global financial system. We do not have the luxury of waiting this time.
The writer was director of the Office of Thrift Supervision at the US Treasury and a principal manager during the height of the savings and loans clean-up and sat on the boards of the Federal Deposit Insurance Corporation and Resolution Trust Corporation. Today he is president and chief executive of the Securities Industry and Financial Markets Association
Copyright The Financial Times Limited 2008
CNBC Video: